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HomeMy WebLinkAboutresolution.council.031-04 RESOLUTION NO. ~ 1 Series of 2004 A RESOLUTION OF THE CITY OF ASPEN, COLORADO, APPROVING A REVISED INVESTMENT POLICY FOR THE CITY OF ASPEN, AND AUTHORIZING THE CITY COUNCIL TO APPROVE SAID DOCUMENT(S) ON BEHALF OF THE CITY OF ASPEN, COLORADO. WHEREAS, the City Council adopted the current Investment Policy on April 26, 1999. Government Finance Officers Association (GFOA) recommends adoption of an investment policy to protect public funds, maintain sufficient liquidity, and earn the highest rate of return. Staff has rewritten the investment policy to clarify and expand the existing investment policy. WHEREAS, there has been submitted to the City Council a summary of changes to the current investment policy, samples of which were supplied by the GFOA and the Municipal Treasurers Association of the United States and Canada, a copy of such documents are annexed hereto and made a part hereof. NOW, WHEREFORE, BE IT RESOLVED BY THE CITY COUNCIL OF THE CITY OF ASPEN, COLORADO: Section One That the City Council of the City of Aspen hereby approves the revisions to the City Investment Policy as referenced above. Dated: ~ !~ ,2004. 'H~l[n ~(.'f'K'hl.ndemd, Mayor I, Kathryn S. Koch, duly appointed and acting City Clerk do certify that the foregoing is a tree and accurate copy of that resolution adopted by the City Council of the City of Aspen, Colorado, at a meeting held ~ /~fi ,2004. Kathryl~ S. ~h; Ci$,f Clerk TLO- saved: 4/13/2004-!95-G:\john\word\resos\investment policy.doc INVESTMENT POLICY March 2004 I. Purpose The purpose of this investment policy is to provide a guideline by which the funds that are not otherwise needed to meet the cash flow demands of the City of Aspen (the City) can best be invested. The objective of the investment portfolio is to earn the highest return for the City within the risk guidelines designed to provide maximum security, while maintaining sufficient liquidity to meet fluctuations in the City's cash flow needs. II. Scope This investment policy applies to all financial assets of the City as identified in the City's Comprehensive Annual Financial Report and includes: 1. General Fund 2. Special Revenue Funds a) Parks and Open Space Fund b) Wheeler Transfer Tax Fund c) Tourism/Regional Transportation Fund d) Parking Improvement Fund e) Affordable Housing/Daycare Fund 3. Debt Service Fund 4. Capital Projects Funds a) Bridges and trails Fund b) Parks and Recreation Facilities Fund c) Tmscott Facilities Construction Fund 5. Enterprise Funds a) Water Fund b) Electric Fund c) Ruedi Hydroelectric Fund d) Transportation Fund e) Golf Course Fund f) Truscott Place Housing Fund g) Marolt Ranch Housing Fund 6. Internal Service Fund - Health Care Self-Insurance 7. Fiduciary Funds a) Castle Ridge Note Receivable Fund b) All Agency Funds Investment income will be allocated to the various funds based upon their respective participation and in accordance with generally accepted accounting principles. Interest will be allocated on a monthly basis. III. Standards of Care 1. Prudence Investments shall be made with judgment and care - under circumstances then prevailing - which persons of prudence, discretion and intelligence exercise in the management of their own affairs, not for speculation, but for investment. The standard of prudence to be used is Standard IV A.1 of the Standards of Practice Handbook of the Association for Investment Management and Research (Appendix A). The Finance Director or his designee must exercise diligence and thoroughness in making investment recommendations or in taking investment actions; have a reasonable and adequate basis, supported by appropriate research and investigation, for such recommendations or actions; make reasonable and diligent efforts to avoid any material misrepresentation in any research report or investment recommendation; and maintain appropriate records to support the reasonableness of such recommendations or actions. The investment officer shall be relieved of personal responsibility for an individual security's credit risk or market price changes if he/she has acted in accordance with written procedures and the investment policy. Ethics and Conflicts of Interest The standard governing Ethics and Conflicts of Interest shall be Standard III(C) of the Standards of. Practice Handbook of the Association for Investment Management and Research (Appendix B). The Finance Director, investment officer, or other must disclose to the City all matters, including beneficial ownership of securities or other investments that reasonably could be expected to interfere with their duty to the City or ability to make unbiased and objective recommendations. The receipt of gifts, gratuities, and travel expenses is governed by the guidelines of the Ethics Policy as adopted by the Aspen City Council on what they or other City Staff may accept from securities dealer firms. Assignment of Responsibilities Article VI, Section 6.8 of the Charter of the City of Aspen grants authority and ultimate responsibility for the investment management activities 0fthe City to the Finance Director. The Finance Director may designate any of the investment functions to another officer of the City (Investment Officer). The Finance Director shall establish written policy procedures for thc operation of thc investment program consistent with this policy. The procedures should include reference to; safekeeping, repurchase agreements, wire transfer agreements, banking service contracts and collateral/depository agreements. Such procedures shall include explicit delegation of authority to persons responsible for investment transactions. No person may engage in an investment transaction except as provided under the terms of this policy and the procedures established by the Finance Director. The Finance Director will establish the day-to-day operating procedures for conducting the City's investment activities. He or she will be responsible for understanding thc risks of the Investment Portfolio and establish the risk measurement and management process. In addition, he or she is responsible for making certain that a system of checks and balances is in place between the purchase/sale decision-making process and the settlement/reconcilement functions. In order to facilitate the evaluation of the investment activities, the Finance Director may employ outside vendors to make periodic appraisals of thc City's investment program or to suggest specific investment alternatives. The Finance Director or his/her designee is authorized to execute security transactions for the City's Investment Portfolio within thc limitations established by this policy. Should unexpected market conditions arise, the Finance Director or his designee may approve a transaction, which would not be in accordance with the Investment Policy but is necessary to protect the safety and liquidity of the City's investment portfolio, and is guided by Section m. 1 of this policy. Such transactions must be reported to the City Council at their next meeting. All securities transactions will be made in accordance with the City's overall interest rate risk profile and policy. Liquidity needs/constraints will also be taken into account when investment decisions are made. IV. Objectives 1. Safety of principal is the foremost objective of the investment program. Investments of the City shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall investment portfolio. To attain this objective, the City will diversify its investments by investing funds among a variety of securities and security types offering independent returns and financial institutions. 2. Liquidity The City's investment portfolio will remain sufficiently liquid to enable the City to meet all operating requirements which may be reasonably anticipated. A prudent reserve shall be maintained to meet unanticipated cash requirements. 3. Return on Investments The City's investment portfolio shall be designed with the objective of attaining a benchmark rate of retum throughout budgetary and economic cycles, commensurate with the City's investment risk constraints and the cash flow characteristics of the portfolio. V. Safekeeping and Custody 1. Authorized Financial Dealers and Institutions The Finance Director or designee will maintain a list of authorized securities firms that have been approved by City Council, through a Request for Proposal process, in accordance with the City's Procurement Code for Contract Formation. This list will include the established limits on unsettled trades, safekeeping arrangements, repurchase agreements, securities lending and borrowing, total credit risk with dealer, and any other transaction with default risk. This list of authorized securities dealers and their established limits will be reviewed annually, by Finance Staff. The Finance Director or designee will be responsible for obtaining sufficient knowledge about securities firms and personnel. Files will be maintained for all firms with which the City transacts investment business. These files will include: a) Financial data, annual reports and credit reports. b) The background data of the dealer's sales representative(s) with whom business will be conducted. c) Any information available from State or Federal regulators or securities industry self- regulatory organizations concermng any formal enforcement actions againSt'the dealer, its affiliates, or associated personnel. d) No public deposit shall be made except in a qualified public depository as established by Colorado law. Internal Controls The Finance Director or designee is responsible for establishing and maintaining an internal control structure designed to ensure that the assets of the City are protected from loss, theft or misuse. The internal control structure shall be designed to provide reasonable assurance that these objectives are met. The concept of reasonable assurance recognizes that (1) the cost of a control should not exceed the benefits likely to be derived and (2) the valuation of costs and benefits requires estimates and judgments by management. Accordingly, the Financial Director or designee shall establish a process for an annual independent review by an external auditor to assure compliance with policies procedures. The internal controls shall address the following points: a) Control of collusion b) Separation of transaction authority from accounting and recordkeeping c) Custodial safekeeping d) Avoidance of physical delivery securities e) Clear delegation of authority to subordinate staff members f) Written confirmation of transactions for investments and wire transfers g) Development of a wire transfer agreement with the lead bank and third-party custodian and 3. Delivery vs. Payment All trades where applicable will be executed by delivery vs. payment (DVP) to ensure that securities are deposited in an eligible financial institution prior to the release of funds. Securities will be held by a third-party custodian as evidenced by safekeeping receipts. VI. Performance Standards 1. Benchmark The City's investment strategy is active. Given this strategy, the basis used by thc Finance Director to determine whether market yields are being achieved shall be to identify a comparable benchmark to the investment portfolio. Examples of benchmark rate return are the 90 day US Treasury Bill, 6 month US Treasury Bill or the average Federal Funds Rate. Reporting Consistent with the City Charter, the Finance Director will provide monthly investment reports, to the City Manager and City Council, which provide a clear picture of the status of the current investment portfolio. The report should include comments on the fixed income markets and economic conditions, discussions regarding percentages of investments by categories, possible changes in portfolio structure and strategy going forward. VII. Statutory Investment Guidelines (Statute: Section 24-75-601, C.R.S.) 1. Custody of Investment Securities Unless otherwise stated, all investments must be held in the City's name, or in the custody of a third party on behalf of the City, or in a custodial account with an eligible public depositOry or securities firm on behalf of the City. 2. Maximum Maturity The maximum maturity date for all securities shall be no more than five years from the date of purchase unless otherwise authOrized by the City, with exceptions noted under limitations included in Section VII, 4 of this policy. 3. Coupon Rate Fixed at Settlement Public funds shall not be invested in any security on which the coupon rate is not fixed from settlement until maturity, other than shares in qualified money market mutual funds, unless the coupon rate is established by reference to specified rate indices, such as the U.S. dollar London interbank offer rate ("LIBOR") of one year or less, or the rate for a U.S. Treasury security with a maturity of one year or less, or the rate of a municipal bond index, or to the cost of funds index, or the prime rate. (Section 24- 75-601.1(1.3), C.R.S.) Legal Investments of Public Funds (Statute: Section 24-75-601.1, C.R.S.) a) U.S. Treasury Bills and Notes b) Federal Farm Credit Bank c) Federal Land Bank d) Federal I-Iomc Loan Bank c) Federal Home Loan Mortgage Corporation f) Federal National Mortgage Association (FNMA) g) Export-Import Bank h) Government National Mortgage Association (GNMA) i) Obligations of any other U.S. agency if control of agency by U.S. is at least as extensive as those investments mentioned above. Security must have highest rating category of at least one recognized rating agency at time of purchase. Obligations of the World Bank, Inter-American Development Bank, Asian Development Bank, and the African Development Bank. Security must have one of two highest rating categories of at least one nationally recognized rating agency at time of purchase. k) G.O. Bonds of any state, District of Columbia, U.S. Territory, or any of their subdivisions. (This includes the State of Colorado and its related entities and Colorado Local Governments and .their related entities.) Security must have one of three highest rating categories of at least one nationally recognized rating agency at time of purchase. Thc Colorado investments may have a maturity in excess of five years. 1) Revenue Bonds of any state, the District of Columbia, a U.S. Territory, or any of their subdivisions. Security must have one of tw° highest rating categories of at least one nationally recognized rating agency at time of purchase. Bankers Acceptance issued by a state or national bank. The bank must have combined capital and surplus of at least $250,000,000. Deposits must be FDIC insured. The bank's long-term debt must have one of three highest ratings of at least one nationally recognized rating agency at time of purchase. Commercial Paper. Security must have the highest rating from at least one nationally recognized rating agency at time of purchase. Any obligation, certificate of participation, or lease-purchase of the City of Aspen. Any interest in any local government investment pool pursuant to Section 24-75-701, et seq., C.R.S. See below. Repurchase Agreements in securities listed in a) through i). Securities of the U.S. Government or its agencies as listed above which must have a coupon rate that is fixed from the time of settlement until its maturity and must be marketable. Market value must at all times be at least equal to funds invested. Title or perfected security interest in securities must be transferred to the City or custodian. Securities must be actually delivered to the City or third-party custodian or trustee for safekeeping. Collateral securities must be collateralized at no less than 102% and marked to market no less than weekly. These investments may have a maturity in excess of five years. A master repurchase agreement must be signed with the bank or dealer. Money Market Funds Must be registered as investment company. Fund investment policies include seeking to maintain a constant share price. No sales or load fee can be added to the purchase or redemption price. The fund invests only in securities that J) m) o) p) q) r) s) t) have a remaining maximum maturity as specified in rule 2a-7 of the federal "Investment Company Act of 1940," as long as such rule or amendment to it does not increase the maximum remaining maturity to a period greater than three years. The fund has assets of $1 billion or more, or has the highest credit rating fi.om one or more nationally recognized rating agency. If the fund has assets of less than $1 billion or has a rating less than the highest credit rating from one or more nationally recognized rating agencies, then the fund's investments must consist only of securities listed a) through c0 above; or perfected reverse repurchase agreements of less than 30 days relating to securities listed in a) through p) above; or securities not listed in a) through q) above that are tax-exempt if these do not exceed 15 percent of the investments of the fund; and the dollar-weighted average portfolio maturity of the fund meets the requirements of rule 2a-7 or amendments to it, so long as such rule or amendment to it does not increase the dollar-weighted average portfolio maturity to a period greater than 180 days. U.S. dollar-denominated corporate or bank debt. Must be issued by a corporation or bank organized and operated within the United States with a net worth in excess of $250,000,000; the notes must mature within three years and must carry at least two credit ratings not below "AA- or Aa3" from any nationally recognized credit rating agency; the book value of investment in this type of debt shall at no time exceed 30 percent of the book value of the City's investment portfolio, or 5 percent of the book value of the City's investment portfolio if the notes are issued by a single corporation or bank. A securities lending agreement using securities authorized in a) through i). Must be entered into with a qualified provider that provides and maintains collateral with a mutually agreed upon custodian. Such collateral shall be in the form of cash or securities that are authorized investments for the public entity and haVe a value equal to 102% of the value of the securities lent by the public entity plus accrued interest. Corporate securities collateral shall have a value equal to 105% of the value of securities. Either the custodian or the qualified provider if verified by the custodian marks to market daily the value of the collateral. If all of the collateral is cash, the difference in valuation need only be resolved if the collateral is less than 100% of the value of the securities. A minimum of 20% of investments purchased with cash collateral matures or is redeemable on any business day; an instrument guaranteed by the US government that has a variable interest rate set off of a money market index readjusted 'every 95 days has a maturity equal to the period remaining until the next readjustment of the interest rate; instrument issued by a corporation that has a variable rate of interest set off of a money market index readjusted every 95 days has a final maturity 30 days or an unconditional put back to the issuer 95 days; the maturity of fixed rate investments or repurchase agreements does not exceed 190 days; the investment maturity or reset date is not greater than 95 days. The securities lending agreement is approved and designated by written resolution duly adopted by a majority vote of the City Council, which resolution shall be recorded in its minutes. Collateralization will be required on purchases of certificates of deposit and repurchase (and reverse) agreements. In order to anticipate market changes and provide a level of security for all funds, the collateralization level will be 102% of par value of principal and accrued interest. Collateral will be held by an independent third party with whom the City has a current Custodial agreement. A clearly marked evidence of ownership must be supplied to the City and retained. IX. Liquidity is the ability to generate cash at a reasonable cost to meet both expected and unexpected demand for fimds from both the City and its vendors without disrupting routine operations or raising adverse questions from funds providers. Maintaining adequate liquidity is essential when conducting normal municipal activity and when providing for potential emergency situations. The City's liquidity position is measured by its capacity to generate funds. Adequate capacity is demonstrated by the ability to raise sufficient levels of cash promptly and at a reasonable cost. This can be accomplished through disposing of liquid assets, increasing short-term borrowing, issuing additional liabilities, decreasing holdings of non-liquid assets, increasing longer-term liabilities, or raising taxes. The goal is to maintain an adequate level of liquidity without impairing the long-term efficient use of the City's assets. Measurement Since no single ratio can define adequate liquidity, the Finance Department will study several ratios to construct the most accurate picture of the state of the City's liquidity position. It is the City's intention to balance the need for liquidity with the need for interest income. The following are measures to assess trends in liquidity: In order to plan for and manage seasonal liquidity needs, liquidity measures will be monitored monthly. The Finance Director or designee will look at cash flows going forward and prepare best/worst case scenarios for funds necessary to meet the City's obligations. on a daily basis, the Finance Director or designee will review local and national economic factors that may affect the City's liquidity or funding needs. This review will include changes to the local economy, interest rate environment, local employment projections, and projected population changes. Administration The liquidity ratios are to be monitored at least monthly (if not weekly or daily). This will ensure that the City has adequate liquidity at all times and assist the Finance Director or designee in assessing trends which could adversely affect the liquidity of the City. Sources of Liquidity The City's primary sources of liquidity are listed below: a) Available Cash Balances. b) Money Market Funds. Excess liquidity will be placed in Money Market Funds in compliance with and monitored under the Investment Policy. c) Maturing securities. The City will ladder its Investment Portfolio to make certain that securities are maturing in accordance with anticipated cash flow needs. The Finance Director or designee will be responsible for establishing a maturity ladder appropriate for the City. d) Investment Portfolio. Securities will be monitored for market value changes to identify e) viable options to be liquidated for liquidity needs. Maximum Maturities. To the extent possible, the City will attempt to match its investments with anticipated cash flow requirements. Unless matched to a specific cash flow, the City will not directly invest in securities maturing more than five years fi.om the date of purchase. However the City may collateralize its repurchase agreements using longer-dated investments not to exceed ten years to maturity. Reserve funds may be invested in securities exceeding ten years if the maturity of such investments is made to coincide as nearly as practicable with the expected use of the funds. Liquidity Contingency Plan In the event that the Finance Director or designee anticipates changes in normal mumcipal operations, it must respond to potential liquidity problems in a thorough and organized manner. By developing a liquidity contingency plan, the City will be able to deal with a potential or real liquidity problem. Asset and liability management procedures should be followed to ensure that adequate cash sources are available and that minimal cash outflows occur. Also, any measures taken to manage liquidity should be in accordance with the parameters regarding interest rate risk. In the event of a liquidity crisis, the City will generate cash to meet its obligations by undertaking one or all of the following steps (in this order): a) Utilize Available Cash Balances. Liquidate money market positions b) Utilize funds fi.om maturing investments c) Liquidate investments provided their market value is close to book value The City Manager and City Council must be informed of any liquidity crisis and provided with the details of the contingency plan. 5. Other Considerations The liquidity management of the City must be made in harmony with the City's Interest Rate Risk Management processes. Any liquidity funding decisions made will directly affect the City's interest rate risk profile. The potential liquidity management decisions should be considered when evaluating the interest rate risk profile of the City. As mentioned above, the City's Investment Portfolio will be laddered to have sufficient maturities to match off against potential maturing liabilities. On an ongoing basis, the Investment Portfolio will be managed within the parameters of both the investment policy and the liquidity management needs of the City. 65 Standard IV: Relationships with and Responsibilities to Clients and prOspects A. Investment Process Standard IV(A.1)--Reasonable Basis and Representations Members shall: a. Exemise diligence and thoroughness in making investment recommendations or in taking investment actions. b. Have a reasonable and adequate basis, supported by appropriate research and investigation, for such recommendations or actions. c. Make reasonable and diligent efforts to avoid any material misrepresentation in any research report or investment recommendation, d. Maintain appropriate records to support the reasonableness of such recommendations or actions. Purpose and Scope of the Standard Standard IV(A. 1) states the responsibility of AIMR members, holders of the Chartered Financial Analyst designation, and candidates in the CFA Program to perform diligent and thorough investigation appropriate to the circumstances for an investment recommendation or action. Members must establish a reasonable basis for every investment recommendation or action, exercise diligence in avoiding any material misrepresentation, and maintain such records and documentation as are appropriate to support that action or recommendation. Standard IV(A. 1) is meant to address the member-client relationship, the role of the member in the investment decision-making process, and the support the organization provides the investment professional in-the performance of this role. These relationships, whether initiated by the. investor (buy side) or by the broker/dealer (sell side), will dictate the nature of the diligence and thoroughness of the research and investigation required by Standard IV(A. 1) and the records in support of the recommendation/ action required by Standard IV(A.2). Members are in compliance if they recommend an investment transaction on the basis of their firm's research; the research of another party who exercised diligence and thoroughness in arriving at a decision; research prepared by a brokerage finn, bank, or investment service for general distribution; or quantitatively oriented research, such as computer-generated screening or ranking of universes of Standards of Practice Handbook 66 Basis ,,for Recommendations common stocks based on various sets of prescribed criteria. For part or all of the background information for general recommendations, a member may depend on reliable sources both within and outside the member's firm. With respect to an individual investment transaction, a member may rely on the same sources but also has the obligation to consider the transaction within the context of a client' s entire portfolio, including client needs and preferences. Generally, the use of reliable sources should be disclosed. Members engaged in corporate finance activities must perform diligent and thorough investigations appropriate to the circumstances with regard to initial public offerings (IPOs), private placements, and secondary offerings, including the proper pricing of any issues. Members must demonstrate a thorough understanding of the industry sector and the issuing company's role within that sector. Members are responsible for performing general industry analysis, company financial analysis, personnel reviews, and studies of use of proceeds, legal matters, potential conflicts of interest, capital structure, and environmental considerations. Members must also make a reasonable and diligent effort to ensure that any research report finding or investment recommendation is accurate. If a member has mason to suspect that any information in a source is not accurate, the member should refrain from relying on that information. The requirements for issuing conclusions on research will vary with the member's investment style, but the member has the responsibility to make reasonable efforts to cover all pertinent issues. In the case of fundamental analysis, such efforts normally would include an examination of historical earnings, ownership of assets, outstanding contracts, and other business factors. A quantitative analyst should concentrate on using valid statistical analysis techniques and on ensuring, to the greatest possible degree, that the conclusions are based on accurate and meaningful data and on as wide a sample as possible. Members should take into consideration accounting and disclosure differences among countries. Variations in the scope and effectiveness of local securities regulations can sometimes lead to misunderstandings on the part of those participating in foreign markets about the nature and extent of the information available to make investment judgments and about the degree of protection afforded public investors. Members are obligated to identify differences between foreign and domestic markets, to consider them in their work, and to inform their clients of any relevant significant differences. Relevant factors include, but are not limited to, the following: · differences in the basis for providing accounting figures; · international variations in the timeliness, depth, quality, and compre- hensiveness of corporate disclosures; ©Association for Investment Management and Research Standard IV(A.1) 67 · the degree of public protection provided by securities laws and regulations; · the general extent of regulatory compliance with laws and regulations; · the degree of liquidity of foreign markets; · tax withholding; · difficulties in settling transactions and other custody issues; · any other relevant factors, such as capital or currency controls. Members should not, for example, compare financial ratios (such as return on equity, debt to equity, or net profit margin) prepared with figures 'presented under different accounting standards without examining the significance of the differences and, where appropriate, making adjustments to ensure comparability. Equally unprofessional would be for a member to ignore (and fail to inform clients of) the risks associated with trading in a foreign securities market if the market has no rules in place---enforced by local governments or stock exchanges--concerning the use by insiders of material nonpublic information. To comply with Standard IV(A. 1), the member must retain records that refer to the specific research analysis or quantitative system used as well as records that indicate reasons for any specific transaction. Members are required to maintain files, including work papers, indicating the scope of their research and reasons for their conclusions. Files should include details of where the data necessary for the analysis were obtained and an account of the method of analysis that is detailed enough to allow reconstruction of the method. Quantitative analysts should document the development and describe the purpose of algorithms used in any investment decision-making process. In the event of real-time or path-dependent quantitatively driven investment systems, the analyst must have the capability to reconstruct the variables and conditions leading up to and precipitating actual transactions and have a basis for demonstrating that these investment systems are functioning as intended. Application of the Standard Example 1. Martin, a quantitative analyst at Allen Brothers, an investment counseling firm, has completed an analysis of return patterns of out-of- favor, low-book-value stocks for the past five years. Based on the study, Martin' s report recommends selling this class of stocks out of all portfolios for which client objectives allow such a move. Comment: Martin's recommendation is not based on thorough quantitative work; to be comprehensive, the work would need to extend over a longer time period. The study should be redone or the recommendation issued in such a manner as to make its limitations obvious. Standards of Practice Handbook 68 Basis for Recommendations Example 2. Jenner works on the fixed-income trading floor of a major investment bank. She supports the sales and trading effort by advising clients and traders about corporate Credit trends and potential rating actions. Noticing that an automotive company is making a large acquisition, she calls the company to obtain more information. She also calls the rating agencies to gauge their responses. With this information in hand, she works up an advisory for interested clients about the credit implications of the company's action. Randall, a senior partner of the firm, has a good relationship with the auto company. He explodes when he discovers that Jenner has contacted the company without his knowing it. He tells Jenner she should never again contact one of "his" companies without his consent. Jenner believes that the restriction ties her hands in such a way that she cannot continue to do her job properly. Comment: Jenner has a responsibility to exercise diligence and thoroughness in forming investment judgments, but she needs to be sensitive to business considerations and balance them against her responsibility. Although Jenner can try to cooperate more effectively with Randall in obtaining needed information, Jenner must also let the firm's clients know when she is "conflicted" or otherwise unable to obtain the information necessary to draw a conclusion. Example 3. Hawk manages the corporate finance department of Black & White Securities, Ltd. (B&W). The firm is anticipating that the government will soon close a tax loophole that currently allows oil and gas exploration companies to pass on drilling expenses to holders of a certain class of shares. Because market demand for the tax-advantaged class of stock is currently high, B&W decides to undertake several new equity financings at once before the loophole closes. Time is of the essence, but B&W lacks sufficient resources to conduct adequate research on all the prospective issuing companies; so, Hawk decides to estimate the IPO prices based on the relative size of each company and to justify the pricing later when her staff has time. Comment: B&W should have taken on only the work that it could adequately handle. By categorizing the issuers as to general size, Hawk has bypassed researching all the other relevant aspects that should be considered when pricing new issues. Such an omission can result in investors purchasing shares at prices that have no actual basis. Example 4. Dhaliwal works for Cloudy Days Brokerage in the corporate finance group. He has just persuaded Starchy Resources, Ltd., to allow his firm to do a secondary equity financing at Starchy Resources stock's current ©Association for Investment Management and Research Standard IV(A.1) 69 price. Because the stock has been trading at higher multiples than similar companies with equivalent production, Dhaliwal presses the Starchy Resources managers to project what would be the maximum production they could achieve in an optimal scenario. Based on these numbers, he is able to justify the price they will be asking for the secondary issue. During a sales pitch to the brokers, Dhaliwal then uses these numbers as the base- case production levels Starchy Resources will achieve. Comment: When presenting information to the brokers, Dhaliwal should have given a range of production scenarios and the probability of Starchy Resources achieving each level. By giving the optimal production level as the likely level of production, he has misrepresented the chances of achieving that production level and seriously misled the brokers. Example 5. Jennings is an international portfolio manager based in Boston, Massachusetts. A client of Jennings who had previously stipulated that all his money be invested in North American blue-chip securities requests that, in the future, Jennings manage his money on an international basis, with emphasis on securities in countries with high rates of economic growth. Comment: As an international fund manager, Jennings must be aware of relevant differences among countries in accounting, disclosure, and compliance standards; market liquidity; capital controls; taxation; and other factors. Jennings must be capable of incorporating such considerations into her assessments of potential risks and returns. Her client may well be unaware of these factors and their potential influence on the amount and volatility of his future investment returns. So, Jennings should explain these factors to her client and allow the client to consider them before altering his investment strategy. Example 6. Witt is a CFA charterholder who has created an Internet site, with a chatroom area, to publish his recommendations. He views the site as a chance to attract new clients. In the chatroom, he almost always writes positively about technology stocks and recommends purchasing what the conventional wisdom of the markets have christened the "hot" Internet- related securities of the day. Comment: Witt's exuberance about technology and conventional wisdom of the markets, without more information, do not form a reasonable and adequate basis, supported by appropriate research and investigation, on which to base a recommendation. Therefore, Witt has violated Standard IV(A. 1). Standards of Practice Handbook ?0 Basis for Recommendations Procedures for Compliance Members can comply with Standard IV(A. 1) by addressing the following areas: · Analyze basic charactersfics. Before recommending a specific investment or investment discipline to a broad client group, a member should investigate the investment's basic characteristics. Furthermore, written records should indicate the characteristics (for example, quality ratings, terms such as "businessman' s risk" or "speculative issue") and the basis for the recommendation (quantitative, fundamental, technical, etc.). A research report can serve as a record of the findings that support conclusions about a particular issue or group of securities. With respect to a quantitative investment discipline, the process should be illustrated in thorough detail, and any applicable backtesting data should be made available for inspection or review. · Analyze portfolio needs. A member has the obligation to analyze clients' inCestment needs as well as the basic characteristics of investments. The analysis of a client's needs and circumstances is not a one-time matter but a continuing responsibility. As for the meshing of client characteristics and investment characteristics, members should keep in mind that a combination of several different investments is likely to provide a more acceptable level of risk exposure than is investing in one or two securities. Also, the basic characteristics of the entire portfolio will largely determine whether client factors are being served. Thus, the focus should be on the characteristics of the total portfolio rather than an issue-by-issue review. At the outset of the relationship, the portfolio manager and client should develop a statement of investment objectives, and they should review this statement periOdically (annually and when a major change in client circumstances occurs). These objectives should be set forth in writing. Each recommendation or transaction should be made in view of client objectives and the basic characteristics of the investment to be bought or sold. · Maintain files. A member should maintain files to support investment recommendations. In addition to furnishing excellent reference materials for future work, research files play a key role in justifying investment decisions under later scrutiny. Files can serve as the ultimate proof that recommendations and actions, good or bad, were made based on the same methodology that drove the analyst's decisions. If recommendations are based on a report from an outside source, the member should keep a copy of the report. If the member undertakes original research, the member should include details of where the necessary data ©Association for Investment Management and Research Standard IV(A.1) were obtained and include enough information about the analytical method to allow the process to be reconstructed. In the case of fundamental research, the member should keep company-published data, industry data, and records of all management contacts. Records and files may be kept on paper or in electronic fOrm. If kept in electronic form, members should maintain adequate backup. Standards of Practice Handbook Standard II1: Relationships with and Responsibilities to the Employer 51 Standard IIl(C)--Disclosure of Conflicts to Employer Members shall: 1. Disclose to their employer all matters, including beneficial ownership of securities or other investments, that reasonably could be expected to interfere with their duty to their em ployer or ability to make unbiased and objective recommendations. 2. Comply with any prohibitions on activities imposed by their employer if a conflict of interest exists. Purpose and Scope of the Standard Standard III(C) protects employers and, indirectly, clients by requiring AIMR members, CFA charterholders, and candidates in the CFA Program to report to employers any conflict of interest. Unlike Standard IV(B.7), which deals exclusively with situations creating a conflict of interest in formulating investment advice and focuses on protecting the client, Standard III(C) deals with conflicts of interest in any actions or decisions of a member and focuses on responsibility to the employer. By reporting conflicts of interest, members should give their employer enough information to assess the impact of the conflict. By complying with employer guidelines, members allow their employers to avoid potentially embarrassing and costly violations. Many investment f'm-ns restrict their employees' actions and investment freedom to avoid conflicts and ensure that client interests come first. Standard III(C) requires that members obey such internal directives and specifies that members use their own judgment to report any potential conflicts that are not covered by their employer's guidelines. Reportable situations include conflicts that would interfere with rendering unbiased investment advice and conflicts that would cause a member not to act in the employer's best interest. The principles that apply to Standard IV(B.7) also apply to the investment recommendation portion of Standard III(C). Ownership of stocks analyzed or recommended, participation in outside boards, and financial and other pressures that may influence a decision are to be promptly reported to the employer so that their impact can be assessed and a decision made on how to resolve the conflict. The mere appearance of conflict of interest may create problems for a Standards of Practice Handbook Disclosure of Conflicts/Em?Ioyer member and the member's employer. Therefore, many of the conflicts mentioned in the preceding paragraph and others could be explicitly prohibited by the employer. For example, many employers restrict personal trading, outside board membership, and related activities to prevent situations that might not normally be considered problematic from a conflict-of-interest point of view but could give the appearance of a conflict of interest. Standard re(c) specifies that every member must honor these restrictions; members must avoid such conflicts and, if they occur inadvertently, must report them promptly so that the employer and the member can resolve them as quickly and effectively as possible. Standard III(C) also deals with a member's conflicts of interest that might be detrimental to the employer's business. Any potential conflict situation that could prevent clear judgment in or full commitment to the execution of the member' s duties to the employer should be reported to the member's employer and promptly resolved. Application of the Standard Example 1. Green is a telecommunications analyst at Alpha, Inc.; an investment manager that caters to large pension funds and foundations. Green is considering a small purchase of DRAM, Inc., a computer chip manufacturer, for his personal portfolio. Green knows that Alpha's policy prohibits all personnel from trading in any equities traded on a U.S. exchange (DRAM trades on the New York Stock Exchange). He also knows that Alpha has no intention of trading in DRAM and that, even if it did, he would have no impact on the DRAM investment decision because he does not cover the computer chip industry. Green believes that his purchase would be sufficiently small to have no material impact on DRAM's trading patterns. Given these considerations, Green decides to purchase shares in DRAM and believes he has no need to report that transaction to Alpha's compliance officer. Comment: In choosing to ignore his employer's trading prohibitions, Green is violating Standard III(C). It is not Green's prerogative to decide unilaterally that Alpha's prohibition against trading in exchange-listed securities can be ignored because his purchase will not create a conflict of interest. He should realize that Alpha's policies are designed not only to prevent material conflict of interest but also to prevent the appearance of impropriety. Green could discuss his wish to purchase DRAM stock with Alpha's compliance officer and request that Alpha make an exception in this case. Without such an exception, however, Green is prohibited from purchasing DRAM. If he makes the purchase, Green should report the transaction immediately to his compliance officer to ©Association for Investment Management and Research Standard III(C) determine how best to unwind the transaction and to determine if disgorgement of any profit is warranted. Example 2. Corky, a senior portfolio manager for Universal Management, recently became involved as a trustee with the Chelsea Foundation, a very large not-for-profit foundation in her hometown. Universal is a small money manager (assets under management of approximately $100 million) catering to individual investors. Chelsea has assets in excess of $2 billion. Corky does not believe informing Universal of her involvement with Chelsea is necessary. Comment: By failing to inform Universal of her involvement with Chelsea, Corky violated Standard III(C). Given the large size of the endowment at Chelsea, Corky's new role as a trustee can reasonably be expected to be time-consuming, to the possible detriment of Corky' s portfolio responsibilities with Universal. As a trustee, Corky also may become involved with the investment decisions at Chelsea. Therefore, Corky should have discussed becoming a trustee at Chelsea with her compliance officer or supervisor at Universal before accepting the position and should have disclosed the degree to which she would be involved in investment decisions at Chelsea. Example 3. Smith covers East European equities for Marlborough Investments, an investment management firm with a strong presence in emerging markets. While on a business trip to Russia, Smith learns that investing in Russian equity directly is difficult but that equity-linked notes that replicate the performance of the underlying Russian equity can be purchased from a New York-based investment bank. Believing that his firm would not be interested in such a security, Smith purchases a note linked to a Russian telecommunications company for his own account without informing Marlborough. A month later, Smith decides that the firm should consider investing in Russian equities using equity-linked notes, and he prepares a write-up on the market that concludes with a recommendation to purchase several of the notes. One note recommended is linked to the same Russian telecom company that Smith holds in his personal account. Comment: Smith violated Standard III(C) by failing to disclose his ownership of the note linked to the Russian telecom company. Smith should have disclosed the investment opportunity to his employer and looked to his company's policies on personal trading to determine whether it was proper for him to purchase the note for his own account. By purchasing the note, Smith may or may not have impaired his ability Standards of Practice Handbook 54 Disclosure of Con, flicts/Employer to make an unbiased and objective assessment of the appropriateness of the derivative instrument for his firm. Smith's failure to disclose the purchase to his employer impaired his employer' s ability to render an opinion regarding whether the ownership of the security constituted a conflict of interest that might have affected future recommendations. Once he recommended the notes to his firm, Smith compounded his problems by not disclosing that he owned the notes in his personal account--a clear conflict of interest. Example 4. Roberts is a portfolio manager at Katama Investments, an advisory firm specializing in managing assets for high-net-worth individuals. Katama's trading desk uses a variety of brokerage houses to execute trades on behalf of its clients. Roberts asks the trading desk to direct a large portion of its commissions to Naushon, Inc., a small broker/dealer run by a business school classmate of Roberts. Katama's traders have found Naushon to be not very competitive on pricing, and although Naushon generates some research for its trading clients, Katama's other analysts have found most of Naushon's research not especially useful. Nevertheless, the traders do as Roberts asks, and in return for receiving a large portion of Katama's business, Naushon recommends the investment services of Roberts and Katama to its wealthiest clients. This arrangement is not disclosed to either Katama or the clients referred by Naushon. Comment: Roberts violated Standard III(C) by failing to inform her employer of the referral arrangement and violated Standard IV(B.8), Disclosure of Referral Fees, by failing to disclose the arrangement to the clients referred by Naushon. If Katama is paying Naushon higher- than-average commissions for little in the way of added benefit, then Roberts also violated Standard IV(B. 1), Fiduciary Duties. Procedures for Compliance Members should report any beneficial interest they may have in securities and any corporate directorships, trustee positions, or other special relationships that they may have that could reasonably be considered a conflict of interest with their responsibilities to their employer. Members should discuss with their compliance officer or supervisor, before taking action, any action by the member that could lead to such conflict. ©Association for Investment Management and Research MCMahaN aND ASSOCIatES, Certified Public Accountants and Consultants SUITE 222/Avon CENTER I O0 WEST BEAVER CREEK BLVD. P.O. BOX 5850 AVON, CO 8 1620 L,l,C, WEB SITE: V~NV~.MCMAHANCPA.COM TELEPHONE: (970) 845-8800 FACSiMILe: (970) 845-085 I E-MAIL: MCMAHAN ~MCMAHANCPA.COM April 9, 2004 City of Aspen 130 South Galena Street Aspen, Colorado Attention: Paul Menter, Finance Director Dear Paul, In our opinion, during your tenure as Finance Director, the City of aspen's investment portfolio has complied with applicable Colorado State statutes and the City of Aspen's Home Rule charter. Furthermore, we fully support your efforts to implement a comprehensive investment policy for the City of Aspen. We appreciate your efforts in keeping us informed with respect to this issue. If we can be of any help in this process please don't hesitate to ask. Sincerely, McMahan and Associates, LLC Paul J. Backes, C.P.A. D. Jerry McMahan, C.P.A. Paul J. Backes, C.P.A. Performing services for local governments throughout Colorado Daniel R. Cudahy, C.P.A. Michael N. Jenkins, C.A., C.P.A. Members: American Institute of Certified Public Accountants/Colorado Society of CerUfied Public Accountants National and Colorado Government Finance officers Association/Colorado Municipal League